Carsales: Result 2015

Is Carsales 'ex-growth' (as the broking analysts might say)? Underlying earnings per share (EPS) grew only 4% in 2015 and this financial year looks like it will be similarly lacklustre.

Of course, 'growth' companies like Carsales don't shoot the lights out every single year. Investors might become accustomed to regular increases – Carsales has produced average EPS growth of 16% over the past five years – but slower periods should also be expected. The 2015 and 2016 financial years look to be an example of the latter.

Revenue still grew quickly in 2015, up 32% to $312m. But most of the increase came from the acquisition of car finance website Stratton last year (see Carsales buys stake in Stratton Finance from 1 Jul 14 (Hold – $10.99). There was a distinct slowing in some second half revenue metrics elsewhere in its core online classifieds business. For example, private revenue – which the company generates when individuals place ads to sell cars – was flat in the second half.

With Stratton earning lower margins than Carsales' online classifieds operations, the overall earnings before interest, tax, depreciation and amortisation (EBITDA) margin fell from 59% to 50%. After deducting higher depreciation and much higher interest expense, net profit grew by only 8% to $103m. But even that was inflated by a one-off accounting gain on its holding in iCar Asia.

Excluding that, underlying net profit rose just 4% to $100m. Underlying EPS came in at 41.7 cents, with total annual dividends declared of 35.3 cents (fully franked). This includes a 17.7 cent final dividend and a somewhat unnecessary 1.4 cent special dividend (the ex date for both is 16 Sep).

EPS of 41.7 cents was below market expectations of around 43 cents. So the market, as is its wont, promptly punished the stock, sending it down by about 5% after the result.

So are we worried?

Not yet. Carsales doesn't look 'ex-growth' even if its online classified business has a slow couple of years. The company is clearly investing in the business, with second half expenses rising 64% (largely due to Stratton). Additional sales and technology staff have also been hired, while the company is investing heavily in tyresales.com.au, which it expects to disrupt the tyre-fitting market.

While Carsales expects to 'maintain' its EBITDA margin in 2016, it expects margin growth thereafter. The implication is that current investments in its cost structure will produce benefits down the track.

International business

Pleasingly, the company's international division is already showing promise, although it's still early days. Profits at South Korea's largest automotive classified business, the 49.9%-owned SK Encar, jumped sharply, already justifying the $126m Carsales paid for its stake last year (see Carsales buys in South Korea from 6 Mar 14 (Hold – $11.23)).

Its other international investments are at an earlier stage. Revenue grew at the 30%-owned WebMotors in Brazil, although profit fell due to investment in the business. Continuing the Latin American theme, Carsales recently announced it would pay US$9m for 65% of SoloAutos, a regional classified site in Mexico. That market remains immature however, so SoloAutos is probably best thought of as a lottery ticket.

Finally, iCar Asia is also making progress, although losses widened due to continued business investment. Interestingly, Carsales chose not to participate in iCar's Asia's recent capital raising, although the reason isn't clear. We'll report on iCar Asia's results separately later this month.

It's fair to say Carsales' international growth strategy is at an earlier stage than Seek's, for example. But with exposure to the leading automotive classified sites in South Korea, Brazil, Malaysia and Thailand, there's excellent potential. On a 'look-through' basis, Carsales' revenue and EBITDA from its international operations was $30m and $10m respectively in 2015. These numbers should grow over time.

Making investments

In the short term, though, making investments domestically and internationally tends to depress profits. The 2016 financial year looks no exception.

Even with decent revenue growth this financial year, higher depreciation and interest costs on the company's net debt of $188m will combine to depress net profit. Our estimate is Carsales will produce EPS of approximately 45 cents in 2016.

This places the stock on a 2016 prospective PER of 23, which is hardly outrageous for such a high quality business. Even so, such a multiple still requires earnings growth down the track.

With prior market expectations of 49 cents in EPS for 2016, there may yet be some share price weakness. Investors looking to pick up Carsales on the cheap may yet get an opportunity.

Our view is that this period represents but a temporary slowdown. While Carsales still commands a premium price, history demonstrates that good things happen to great businesses.

With the stock up slightly since Carsales: Interim result 2015 from 23 Feb 15 (Buy – $10.17), our recommendation remains BUY.

Note: The Growth Portfolio and Income Portfolio both own shares in Carsales.